Stone-Age Banking, Anti-Speculation and Rescuing the Euro

With health-care reform in tatters, unemployment and the deficit blamed on the government, and foreign policy reaping a harvest of defiance and contempt by Israel, Iran and the Afghans, President Obama sought consolation in the only area where he and popular emotions were still at one: in banker-bashing. Lest his proposed great banking reform should look too much like pandering to crass populism, he found a prestigious ally in the venerable Paul Volcker, a former Federal Reserve chairman of formidable reputation and what seems to be nostalgia for stone-age banking. The Obama plan has been launched as the Volcker Plan and is likely to fare better at the hands of Congress than any of the other great White House initiatives.

The Volcker Plan would restore the spirit if not the letter of the long defunct Glass-Steagall Act that used to forbid retail banks to engage in investment banking and vice versa. The intention is to make the former safe from the "speculative" risks of the latter. It would bar trading for own account by retail banks and limit their size to a maximum to take care of the "too big to fail" syndrome. Mr. Volcker stated that the latter provision affects only five U.S. banks and another 10 or so non-U.S. ones—the latter reflecting the habitual American assumption that U.S. law applies to German, Swiss and French banks as a matter of course. It is amusing to note that the Volcker Plan sees the chief danger to the banking system the "speculative" trading of banks for their own account. Both the Controller of the Currency and the former chairman of the Securities and Exchange Commission have stated explicitly that such trading has not been a source of significant loss, and that the near-crash of the banks in 2007-2008 was caused, not by "speculation", but by bad lending to credit-unworthy house owners and credit cards debtors on silly conditions. So-called "toxic" securities that turned out to be almost unmarketable, were not made "toxic" by their intrinsic wickedness and rocket-science sophistication, but by the underlying loans that were non-performing. The rest of the world banking upset was the snowball effect of lost confidence, flogged on by panic-mongering by those who should have known better.

Be the facts as they may, the common belief, incessantly repeated by self-appointed experts, remains unshaken: it was all caused by deregulation that allowed the greedy bankers, fund managers and their ilk to engage in "speculation" instead of financing the "real" economy. There is an ineradicable belief that the shuffling of "paper assets" is divorced from the "real economy", or indeed harms it. Virtually everybody, including the regulatory authorities in both the United States and Europe, is sure that speculation is wicked and the harder it is trodden on, the better it is for the economy—besides making capitalism a little less immoral.

For more on exchange rates and speculation, see Foreign Exchange, by Jeffrey A. Frankel, in the Concise Encyclopedia of Economics.

This is arrant nonsense on a par with voodoo. Nobody is very clear about what is and what is not speculation, but if pressed, most would say that speculation is the buying of securities and commodities with the sole object of rapid resale, or the selling of them with the sole object of rapid repurchase. It is wicked because it yields easy money and, as Mervyn King, the Governor of the Bank of England, likes to say, it is "not socially useful". Some even think it is harmful to legitimate business and to stability. "Bear" speculation that starts with sale and ends with repurchase is thought to be particularly vicious and is heavily restricted; if the public had its way, it would be outlawed altogether.

A little horse sense suffices to see why this is absurd and why speculation is "socially" and in every other way eminently useful. If it makes money, it has bought low and sold high, or sold high and bought back low. In either case, it was a buyer at or near the trough and a seller at or near the peak of the fluctuating price of the asset or commodity the speculator "attacked". His "attack" lifted the price when it was low and lowered it when it was high. It reduced volatility, the amplitude of price movements, below what it would otherwise have been: it stabilised the unstable.

The much-hated speculation has just rendered an albeit indirect but useful service to economic stability in Europe by "attacking" (as the commentators put it) the euro and thus ringing the alarm bell about reckless government spending. For at least a decade, the Greek state has been running at a rapidly rising deficit without anyone paying much attention. Had Greece retained the drachma as its money, one or more devaluations would have taken place, but with the euro, the exchange rate no longer acted as a signal nor as a regulator of Athenian housekeeping. Creative accounting showed only half of the real deficit. When early this year it became public knowledge that the deficit was running at 12.7 per cent of GDP the euro started to fall in relation to the dollar and a "short" position in euro of $8 billion opened up in the forward exchange market. In relation to the volume of trade and payments in euros, this sum is hardly more than a rounding error, but its appearance raised the alarm about a speculative "attack" upon Fortress Europe through the Greek back door that was left ajar. Next April and May, 20 billion of Greek state debt is due for redemption and there seemed a real possibility that Athens will be unable to raise the means to pay it. There was much talk of speculators smelling blood, turning upon Portugal, Spain and Italy once they drove Greece into bankruptcy and presumably out of the euro zone. Though the actual volume of speculation was probably quite modest, public rumour and imagination magnified it and feared that it was due to grow much larger, toppling one "Club Med" country after another. Greek Premier Papandreou spoke darkly about a "battle between Europe and the market".

The question of how a modern state can go bankrupt deserves a moment's reflection. When the currency was all metallic and credit creation was confined to the discounting of short trade bills, a state could simply run out of money if its power to squeeze taxes out of its subjects fell short of its needs and ambitions. Charles II of England in 1672 had to go cap in hand to Parliament to be bailed out by extra taxes. With paper currency, whatever the nominal independence of the central bank, a state can always print the money it needs to pay off any debt provided it is denominated in its own currency. Moody's has been muttering lately that it will have to rethink the triple A rating of U.S. government debt. This is childish talk: the United States may well own a trillion dollars to Asian governments, it can always print one trillion dollars in fresh Treasury bills to pay it off. (It is truly laughable that the credit insurance premium on Unilever's 5-year debt at 0.48 per cent is actually lower than the credit insurance premium on 5-year U.S. Treasury bonds 0.64 per cent. The real problem is limited to debt in another state's currency that the debtor state cannot print. The ominously rising government debts of Greece, Portugal, Spain and Italy are in euros and dollars, and they cannot print either of the two. The European Central Bank could give them euros against fresh debt obligations of their own, but should it do so if the latter are potentially worthless? If anyone in Europe has broad enough shoulders to take responsibility for such operations, it is Germany.

Joseph Stiglitz, the Nobel Laureate economist who has lately become the undisputed star commentator on every aspect of every nation's economy, has taken time off from calling for a radical enlargement of the Volcker Plan to put the banks in their place and from urging unemployment to be reduced, to condemn what he called "fiscal fetishism". It is only fiscal fetishism, a stone-age, superstitious fear of persistent deficits, that stands in the way of bailing out Greece or anyone else in need of it, and thus present needless austerity and more unemployment.

Due in part to worries about the power of speculation (also it just smoothes the way for fatal outcomes that are destined to happen anyway), Germany does not want to take on the burden of paying off Greek debt today and perhaps other Club Med debt tomorrow. Using Brussels as proxy, she is telling the Greeks to do what it takes to put their house in order, with mid-March being the deadline for them to show that they are doing so. The Greek response so far is that they have gone to the limit of austerity and if Brussels were to insist on more, Greece would collapse and bring down the euro with it. This is fairly obvious counter-bluff to neutralise the Brussels bluff. The euro will not unravel, Greece will not collapse but will be bailed out in a minor way while making moderate progress toward cleaning up its fiscal house. If speculation had not rung the alarm, things might have drifted further down.

*Anthony de Jasay is an Anglo-Hungarian economist living in France. He is the author, a.o., of The State (Oxford, 1985), Social Contract, Free Ride (Oxford 1989) and Against Politics (London,1997). His latest book, Justice and Its Surroundings, was published by Liberty Fund in the summer of 2002.